S&P500 Q3 earnings: A struggle to meet revenue expectations

• Revenue is investors' focal point
• Development does not look good so far
• Positive EPS surprises based on cost cutting do not impress investors
• Revenue surprise but EPS miss gets a stock hammered. 

Last week was the first big week in terms of companies reporting. So far 118 companies out of the 498 expected this season have reported, just shy of 25 percent. We are therefore able to give a better estimate on the overall direction on the season but we still need to be cautious. The signs are right now pointing to overall trouble keeping up revenue, as most sectors except finance are struggling. EPS surprises are on average so far, around 3.1 percent, not taking the huge miss from Advanced Micro Devices (NYSE:AMD) into account.

What are we able to read so far?
Overall the revenue is has been close to the expected level with 0.1 percent above expectations, see table 1. Looking into the sectors, financials are ahead by 2.9 percent. This has been the big surprise so far, and has been the savior on the top line. Consumer Discretionary is the runner-up, but revenue there has only grown by 0.3 percent. A row of sectors have missed revenue expectations: Health Care, Industrials, IT and Materials. Looking at these sectors gives a more correct picture of the overall state of the US economy, as finance is in a turnaround. Companies have spent Q3 struggling to hold the topline.

Looking at EPS, it has been the IT sector which is the overall sinner, a massive 74 percent below expectations. But this is skewed by AMD with a massive miss dragging the overall numbers down. Taking AMD out, there is still a miss of about 3 percent in tech. The news headlines were caught by Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) missing EPS by about 30 and 10 percent respectively.

Overall, companies are having trouble boosting revenue but margins have been preserved by cost cutting and efficiency measures. This is not a mixture companies can rely on in the longer perspective, so it does bring some extra gray hairs of worry going forward.

The split of the surprises
Earnings are surprising positively 64 percent of the time and missing it in 34 percent, see table 2. On revenue the development has changes from Q2's approximately 50/50 to now a 59 percent of companies missing on revenue. This is a bad sign.

Last time I wrote about the earnings season, the overall price reaction was a relative drop of 0.8 percent on the reporting companies versus S&P500. This picture has not changed, as the measure is -0.8 percent again, see table 3. But this disguises some larger changes. Revenue has become much more in focus from investors. Positive revenue surprises are lifting stock performance by 0.6 percent. Earlier in the season EPS was in focus, so even positive revenue suprises were not enough to boost the stock if EPS wasn't impressive. In Q3 so far, investors have been reacting negatively to revenue misses, even if EPS has surprised positively, as this is seen as an unstable business combination over the longer term. EPS surprises based on cost cutting caused stock prices to fall by 1.3 percent relatively!

Surprise development over the season
Revenue/sales surprises had a fairly balanced development until 16th October. Since then, revenue misses have shown up in big numbers and changed the overall dynamic. Net, revenue surprises have clearly been a negative.

Net EPS surprise is still into positive territory, but the end of last week had a load of companies with negative surprises which dragged the net down, blue line in chart 2.

Conclusion
Last week give us some more insights to the overall season, as we now have 118 companies to derive some conclusions from. Overall, revenue is now the focal point as we now see investors' price reaction show their worry. Cost cutting is not a valid business model in the long run and therefore surprises based on this are not endorsed as much. Looking into next week revenue will be a key factor to keep an eye on.  

Read my earlier story:  S&P 500 earnings: Dour tone, despite positive EPS surprise.